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Fed’s Tougher Task Shouldn’t Knock Investors Off Target

September 18, 2015
Federal Reserve's tough decisions

Editor's note: This article, originally published on September 14, has been updated to reflect the Federal Reserve's September 17 decision to leave interest rates unchanged.

The Federal Reserve faces a tougher task than usual as it contemplates reversing ultra-low interest rate policy while much uncertainty spins throughout the global economy. The challenge of the Fed’s next chapter extends to long-term investors who’ve spent the better part of the year thinking and rethinking the next course for interest rates and their portfolios.

Fed members, by a 9-to-1 vote, in mid-September refrained from the first interest rate hike in nearly 10 years. But they kept alive market speculation that a rate hike is on the table for either (or both) of the Fed's remaining 2015 meetings, one in October and one in December. And the Fed's acknowledgement of global growth concerns—especially surrounding China—also likely keeps financial markets on high alert that conditions could get worse, not better.

The day after that Fed decision, futures traders were pricing in about an 18% probability the central bank increases its target interest rate range in October, a 44% chance by the December meeting, and a 53% likelihood by January.

No one’s denying that these volatile market conditions are stomach-churners. But they shouldn’t knock investors off a focus on company fundamentals and the Federal Reserve’s need to wean the U.S. economy from extraordinarily low interest rates—an act that will mark the Fed’s stamp of approval on a healthy economy.

For sure, the Fed and the investing masses are watching wild global stock market swings chew up short-term stock charts. Many wonder if lost wealth and waning consumer confidence carry the potential to derail an already vulnerable economy in China, Europe, and other growth pockets. Former Treasury Secretary Larry Summers has said that China—a huge customer in the U.S. bond market—may return funds home. That exodus would push down bond prices and push up yields (aka interest rates), essentially doing some of the Fed’s heavy lifting.

Why Think Short Term Now?

It’s true that traders and the buy-and-hold legions can’t ignore stock moves of the magnitude that gripped the globe in late August and early September. But it’s also true that the underlying economic fundamentals, corporate climate, and the Fed’s already telegraphed go-slow approach for pushing up near-zero interest rates hasn’t changed—or at least, hasn’t changed all that much.

The Fed was already dealing with spotty conditions regardless of market performance. The August “rout appears to be a delayed reaction to several developments: recent softness in credit markets, the sell-off in emerging markets, and general concerns over the state of the global economy,” said Russ Koesterich, BlackRock Global’s chief investment strategist. “Recent U.S. economic data have generally been encouraging, but it is worth highlighting that much of the data have been consistently below expectations for most of the year.”

Remember, for long-term investors and the economy, interest rate policy is not a fine tool. It usually takes between six and 12 months for the economy to feel the stimulation effects of lower rates. It also takes time for the economy to slow down as a result of higher rates. All told, any shift in economic fundamentals—and the fundamental decision-making at the Fed—may not have changed as much as shell-shocked stock investors suppose.

Further Reading

Here, we revive some summer posts—a collection of Ticker Tape articles aimed to unlock some of the Fed’s thinking and prep stock and fixed income investors for a gradual shift toward higher interest rates—whenever that may be:

Market Reactive: Hike Rates Now? Fed Mystery Alive

The Fed is in a policy jam. The rates-setting bank of banks is stuck between signs of improving U.S. economic fundamentals and the uncertainty sparked by a global stock sell-off. Investors are caught up in rates uncertainty, too, as no clear message came down from the mountain.

Retail Sales and Fed Policy: Is the U.S. Consumer Spending?

The Federal Reserve is impressed with job market improvement, but wants more concrete evidence that confident workers are spending on homes, cars, and other big-ticket goods. Why has the consumer been so hard to pin down, and what tools can help investors figure out consumer behavior?

See Ya, 0%—What Rising Rates Mean for Bond Investments

While global growth snags leave most other central banks loosening their monetary policy as mid-2015 nears—including Europe’s and China’s—the U.S. appears willing to nudge short-term rates up from the unprecedented, effectively 0% short-term Fed funds target that’s been a fixture in fixed income markets.

Remember CDs? Interest Rate Hikes Could Unlock Demand

Rising interest rates are generally positive for buy-and-hold fixed income investors and anyone trying to collect a little interest on savings, certificates of deposit (CD), and money market accounts. The rise of rock-bottom interest rates could revive demand.

Feeling Sensitive? Interest Rate Hikes May Tickle These Sectors

Tighter interest rate policy is bullish for the broad market, even if it’s met by a collective grumble on Wall Street. It means the Fed is confident in economic growth. Of course, some stock sectors are more sensitive to interest rate changes than others.

Experts Discuss Fed's Market Impact

Find out how rising interest rates might impact your portfolio. Watch the webcast replay from September 15, featuring TD Ameritrade's JJ Kinahan, for perspectives on stocks, and Craig Laffman, for perspectives on fixed income.

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